Common-Size Analysis of Financial Statements

It can be used to compare the company’s performance within one year, year on year, or against competitors. For example, large drops in the company’s profits in two or more consecutive years may indicate that the company is going through financial distress. Similarly, considerable increases in the value of assets may mean that the company is implementing an expansion or acquisition strategy, potentially making the company attractive to investors. While these statements can be useful in analyzing financial performance, they have several limitations that should be considered. First, the cost of goods sold (COGS) for the business firm has increased from Year 1 to Year 2. The COGS usually includes direct labor costs and the cost of direct materials used in production.

The use of common-size statements facilitates vertical analysis of a company’s financial statements. The most frequent common size financial statements include the likes of the cash flow statement, the income statement, and the balance sheet. Essentially, it allows data entries to be listed as a percentage of a common base figure.

This is instead of a traditional financial statement that would list items as absolute numerical figures. While common size balance sheets are not a requirement of generally accepted accounting principles (GAAP), they offer a number of benefits to both internal and external parties. Common size financial statements, also known as vertical analysis, are a type of financial statement that expresses each financial item as a percentage of a base amount. The base amount used in common size statements is typically total assets for the balance sheet and net sales for the income statement.

Common Size Balance Sheet: Definition, Formula, Example

Common size financial statements are useful for financial analysis and decision-making. They can help identify trends in the composition of an organization’s financial data and highlight areas where changes may be needed. Common size statements are often presented in a tabular form, with columns for each financial item and rows for each period being compared. The common size statement is an “income statement”, where every account is indicated as “a percentage of the value” of the sale. It is used for vertical analysis, in which in the “financial statement”, each line data is registered as a “percentage of the base”, making it easier to compare. This type of analysis is used to analyze a company’s financial statements to identify patterns and trend lines, and to compare a company against competitors.

For example, suppose BP’s cost of goods sold was 73% of revenue for 2021, and its close competitor Chevron’s cost of goods sold was only 59% of revenues. In that case, an analyst may determine that Chevron’s management team is better than BP’s at controlling expenses. This may factor into investment decisions and ratings given to a company by external stakeholders.

They can make important observations by analyzing specific line items in relation to the total assets. When you show the items on the income statement as a percentage of the sales figure, it makes it easier to compare the income and expenses and understand the financial position of the company. Common size analysis is an excellent tool to compare companies of different sizes or to compare different years of data for the same company, as in the example below. In income statements, line items are most often divided by total revenues or total sales. If Company A had $2,000 in operating expenses and $4,000 in total revenues, the operating expenses would be presented as 50%. Although the information presented is useful to financial institutions and other lenders, a common size balance sheet is typically not required during the application for a loan.

Common Size Analysis, also known as Vertical Analysis, is used to analyze a company’s financial statement information. This method uses one line item on the statement as a base against which to evaluate all other items in the same statement. It is called common-size because it makes companies within an industry comparable irrespective of size.

What is a Common Size Balance Sheet?

You’ll find the usefulness of this technique comes from analyzing and interpreting the results. When comparing two companies in the same industry, even if they are of very different sizes, common-size data enables you to make an apples-to-apples comparison, because you’re comparing relative amounts. For example, regardless of a company’s size, the advertising expense should be about 15 percent of sales for a given industry. Let’s say that you’re looking into the line items on an income statement for a company.

Since we use net sales as the base on the income statement, it tells us how every dollar of net sales is spent by the company. For Synotech, Inc., approximately 51 cents of every sales dollar is used by cost of goods sold and 49 cents of every sales dollar is left in gross profit to cover remaining expenses. Of the 49 cents remaining, almost 35 cents is used by operating expenses (selling, general and administrative), 1 cent by other and 2 cents in interest. We earn almost 11 cents of net income before taxes and over 7 cents in net income after taxes on every sales dollar. This is a little easier to understand than the larger numbers showing Synotech earned $762 million dollars.

What Is the Main Purpose of Common Size Financial Statements?

In conclusion, it can be said that the common size income statement facilitates easy comparison. It makes analysis much easier such that the analyst can see what is actually driving the profit of a company and then compare that performance to its peers. how to calculate percentage in common size balance sheet Common size analysis, also referred to as vertical analysis, is a tool that financial managers use to analyse financial statements. It evaluates financial statements by expressing each line item as a percentage of the base amount for that period.

But the above can serve as an example of what can be gleaned using common-size analysis to evaluate the income statements of competing organizations. It is important to add short-term and long-term debt together and compare this amount to the total cash on hand in the current assets section. This lets you know how much of a cash cushion is available or if a firm is dependent on the markets to refinance debt when it comes due. As of your balance sheet date, A/R represents 15 percent of total assets. However, a more popular version breaks down cash flow in a different way and expresses line items in terms of cash flows from operations.

How do you find common size?

This is by using proportion rather than the actual numbers as the means of comparison. Although this kind of analysis can be performed on many types of financial statements, the balance sheet and the income statement are most commonly analyzed using this tool. Common size financial statements can be used to compare multiple companies at the same point in time.

For example, a short-term drop in profitability could only indicate a speed bump rather than a permanent loss in profit margins. Operating profit is one of the most important numbers you can analyze because it shows the health of the business firm’s core business. You can also prepare for the other statements, but that would not be as perfect and informative as these two statements could be. Lastly, it is prepared for the assessment of the financial soundness of the organisation and to understand its financial strategy. Goldman Sachs has markedly decreased its expenses from 2020 to 2021, whereas Morgan Stanley did not. Cynthia Gaffney has spent over 20 years in finance with experience in valuation, corporate financial planning, mergers & acquisitions consulting and small business ownership.

Part-B Chapter 1: Overview of Computerised Accounting System

While the balance in the equipment account did change as a percentage of total assets, equipment remained the same at 20 percent. Using this statement, users could quickly see the percentage of each item, cash or account receivable, compared to total assets. A common-size balance sheet is an alternative form of the traditional balance sheet that uses percentages instead of dollar amounts. It helps business owners, investors and bankers compare companies of different sizes without revealing actual dollar amounts. In the short term, a company’s executives can compare the firm’s percentages to the industry’s average percentages. They can also use the common-size balance sheet’s information to review their long-term assets and liabilities, and address any significant changes.

• Historical comparisons can be made in a time-series analysis to identify such trends.
• Notice that the $ can be inserted to anchor a cell reference, making it easier to copy and paste the same formula onto many lines or columns.
• Share repurchase activity as a percentage of total sales in each of the three years was minimal or non-existent, possibly due to economic and market conditions resulting from the Covid-19 pandemic.
• You simply select the appropriate report format and financial statement date, and the system prints the report.
• It can also highlight the expense items that provide a company a competitive advantage over another.

It will also include total financing cash flows and total investing cash flows for both of those activities. Before breaking down the different types of common size analysis, it’s worth understanding that it can be conducted in two ways. Now that you have covered the basic financial statements and a little bit about how they are used, where do we find them? In this next section we will explore the requirements for what needs to be reported, when, and to whom.

Figure 13.8 “Comparison of Common-Size Gross Margin and Operating Income for ” compares common-size gross margin and operating income for Coca-Cola and PepsiCo. In general, managers prefer expenses as a percent of net sales to decrease over time, and profit figures as a percent of net sales to increase over time. As you can see in Figure 13.5 “Common-Size Income Statement Analysis for “, Coca-Cola’s gross margin as a percent of net sales decreased from 2009 to 2010 (64.2 percent versus 63.9 percent). Income before taxes increased significantly from 28.6 percent in 2009 to 40.4 percent in 2010, again mainly due to a one-time gain of $4,978,000,000 in 2010. This caused net income to increase as well, from 22.0 percent in 2009 to 33.6 percent in 2010. In the expense category, cost of goods sold as a percent of net sales increased, as did other operating expenses, interest expense, and income tax expense.

What is Common Size Analysis?

Most accounting computer programs, including QuickBooks, Peachtree, and MAS 90, provide common-size analysis reports. You simply select the appropriate report format and financial statement date, and the system prints the report. Thus accountants using this type of software can focus more on analyzing common-size information than on preparing it. Balance sheets and income statements may be prepared by taking the following information. You can compare and get results of different financial periods of the same company or other companies in the same industry. The income from selling the products or services will show up in operating profit.

• Common size statements are generally prepared for company income statements and balance sheets.
• The same process would apply on the balance sheet but the base is total assets.
• The most valuable aspect of a common size balance sheet is that it supports ease of comparability.
• Running through some of the examples touched on above, we can see that long-term debt averages around 34% of total assets over the two-year period, which reasonable.
• The
  value is all determined by comparing each expense with the total sales.
• If a Common-size Balance Sheet is prepared for the industry, it facilitates the assessment of the relative financial soundness and helps in understanding the financial strategy of the organisation.

On the other hand, horizontal analysis refers to the analysis of specific line items and comparing them to a similar line item in the previous or subsequent financial period. Although common size analysis is not as detailed as trend analysis using ratios, it does provide a simple way for financial managers to analyze financial statements. Similar to an income statement analysis, many items in the cash flow statement can be stated as a percent of total sales.

Using Clear Lake Sporting Goods’ current balance sheet, we can see how each line item in its statement is divided by total assets in order to assemble a common-size balance sheet (see Figure 5.22). However, a simple tool like Microsoft Excel can be quite handy in making the process easier and faster. The same formula can be copied and replicated in each income statement line, making the calculations much faster. In Figure 5.21, you can see the formulas used to create Clear Lake Sporting Goods’ common-size income statement in Excel. Notice that the $ can be inserted to anchor a cell reference, making it easier to copy and paste the same formula onto many lines or columns. Common-size analysis enables us to compare companies on equal ground, and as this analysis shows, Coca-Cola is outperforming PepsiCo in terms of income statement information.